THEORY OF CONSUMER BEHAVIOR
THEORY OF CONSUMER BEHAVIOR
We will study the behaviour of a individual consumer in a market for final goods. Economist assume that consumer choose the best bundle of goods they can afford.
Consumer Budget
1. Indifference curves always slope down from left to the right.
2. Higher indifference curves represent higher level of satisfaction.
3. Indifference curves are always convex to the origin O.
4. Indifference curves cannot intersect each other.
5. Indifference curve touches neither X-axis nor Y-axis
A consumer is in equilibrium at a point where budget line is tangent to indifference curve. At this point; slope of indifference curve (called MRS) is equal to slope of budget line
The marginal rate of substitution (MRS) can be defined as how many units of good x have to be given up in order to gain an extra unit of good y, while keeping the same level of utility. It can be determined using the following formula:
We will study the behaviour of a individual consumer in a market for final goods. Economist assume that consumer choose the best bundle of goods they can afford.
Consumer Budget
It is the real purchasing power of the consumer from which he can purchase the certain quantities of bundles of two goods at a given prices. In other words the consumption bundle available to a consumer depends on two things - the prices of two goods and The Income of the consumer. (The consumer can afford to buy only those bundles which cost him lees than or equal to his income).
BUDGET SET:
The set of two goods available to buy a consumer with his income is called budget set: The equation of the budget set is 𝑃1𝑋1 + 𝑃2X2 ≤ M. Here P1 Price of first good. X1 is the amount of good 1. P2 is the price of second good and X2 is the amount of second good. There is an inequality in the budget set equation is called budget constraint. P1,P2 and M are the budget constraints.
in other words - It is the set (collection) of all the bundles that the consumer can buy with his income at the prevailing market prices.
𝑃1𝑋1 + 𝑃2X2 ≤ M
For example Mr. Darshan’s income is Rs 20/- He can purchase two goods both are price at Rs 5/- his budget set is( 0,0), (0,1 ), (0,2 ), (0,3 ), (0,4 ), (1,0 ), (2,0 ), (3,0 ), (4,0 ), (1,1 ), (1,2 ), (1,3 ), (2,0 ) (2,1 ), (2,2 ), (3,0 ), (3,1 ),(4,0 )
Out of this bundles (0,4 ), (1,3 ), (2,2 ), (3,1 ), (4,0 ) cost exactly same and all other bundles cost less than Rs 20/-
The set of two goods available to buy a consumer with his income is called budget set: The equation of the budget set is 𝑃1𝑋1 + 𝑃2X2 ≤ M. Here P1 Price of first good. X1 is the amount of good 1. P2 is the price of second good and X2 is the amount of second good. There is an inequality in the budget set equation is called budget constraint. P1,P2 and M are the budget constraints.
in other words - It is the set (collection) of all the bundles that the consumer can buy with his income at the prevailing market prices.
𝑃1𝑋1 + 𝑃2X2 ≤ M
For example Mr. Darshan’s income is Rs 20/- He can purchase two goods both are price at Rs 5/- his budget set is( 0,0), (0,1 ), (0,2 ), (0,3 ), (0,4 ), (1,0 ), (2,0 ), (3,0 ), (4,0 ), (1,1 ), (1,2 ), (1,3 ), (2,0 ) (2,1 ), (2,2 ), (3,0 ), (3,1 ),(4,0 )
Out of this bundles (0,4 ), (1,3 ), (2,2 ), (3,1 ), (4,0 ) cost exactly same and all other bundles cost less than Rs 20/-
BUDGET LINE (or Price Line)
P1x1 + P2x2 = M
A budget line is based on income (M) and prices (PX & Py). Thus, it changes when there is a change in M, PX, & PY
Preference of “more is better”. Monotonic preference means that consumer preference between any two bundles of goods which has more of at least one of the good and no less of other goods compared to the other bundle. A consumer with monotonic preference will prefer the bundle (2, 3) to bundles (2, 1), (1, 3) and (2, 2) bundles or a consumer with monotonic preference will prefer the bundle (2, 2) to (1, 1), (2, 1) and (1, 2) bundles
Prof. J.R. Hicks and R.G.D Allen called utility approach unrealistic because satisfaction (utility) being subjective/ mental phenomenon can never be measured precisely. They, therefore, presented an alternative technique known as Indifference Curve Analysis (This is called Ordinal Measure of utility
An indifference curve is a curve that represents all those combinations of two goods which give equal satisfaction to the consumer. The consumer has no reason to prefer one particular combination to any other combination on the same curve. So he is indifferent (neutral) towards various combinations of two goods giving same level of satisfaction and, therefore, such a curve is called indifference curve. If we show these combinations on a graph and join these points to form a curve, it is known as an indifference curve
Thus an indifference curve is the locus of all points representing various combinations (also called bundles) giving equal satisfaction towards which a consumer is indifferent.
P1x1 + P2x2 = M
Change in Budget
line
A budget line is based on income (M) and prices (PX & Py). Thus, it changes when there is a change in M, PX, & PY
Preferences: what
the consumer wants?
It means choosing one good over another. E.g. Darshan prefer Coffee to tea.
Monotonic
preferences
Preference of “more is better”. Monotonic preference means that consumer preference between any two bundles of goods which has more of at least one of the good and no less of other goods compared to the other bundle. A consumer with monotonic preference will prefer the bundle (2, 3) to bundles (2, 1), (1, 3) and (2, 2) bundles or a consumer with monotonic preference will prefer the bundle (2, 2) to (1, 1), (2, 1) and (1, 2) bundles
Indifference
Curve Analysis
Prof. J.R. Hicks and R.G.D Allen called utility approach unrealistic because satisfaction (utility) being subjective/ mental phenomenon can never be measured precisely. They, therefore, presented an alternative technique known as Indifference Curve Analysis (This is called Ordinal Measure of utility
Indifference
Curve
An indifference curve is a curve that represents all those combinations of two goods which give equal satisfaction to the consumer. The consumer has no reason to prefer one particular combination to any other combination on the same curve. So he is indifferent (neutral) towards various combinations of two goods giving same level of satisfaction and, therefore, such a curve is called indifference curve. If we show these combinations on a graph and join these points to form a curve, it is known as an indifference curve
Indifference Map
An indifference map is a collection of indifference curves corresponding to different levels of satisfaction Thus it is a family of indifference curves. It gives a complete picture of a consumer's scale of preferences for two goods as it represents different levels of satisfaction
Properties of
indifference curves are:
1. Indifference curves always slope down from left to the right.
2. Higher indifference curves represent higher level of satisfaction.
3. Indifference curves are always convex to the origin O.
4. Indifference curves cannot intersect each other.
5. Indifference curve touches neither X-axis nor Y-axis
Consumer's
Equilibrium through Indifference curves.
A consumer is in equilibrium at a point where budget line is tangent to indifference curve. At this point; slope of indifference curve (called MRS) is equal to slope of budget line
Marginal Rate of
Substitution (MRS)
The marginal rate of substitution (MRS) can be defined as how many units of good x have to be given up in order to gain an extra unit of good y, while keeping the same level of utility. It can be determined using the following formula:
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